One of the basic principles of compliance is that an investor need for protection is inversely proportional to his/her expertise. In other words, expert investors need less protection than retail investors or non-experts. And yet on both sides of the Atlantic politicians are bringing in regulations that have the apparent aim of protecting the expert investors.
Prudence in banking is mandatory; hedge funds were initially created by fund managers that thought they could achieve better returns by taking ‘informed’ risks. Dealing only with institutions and expert individuals (i.e. very wealthy) they are supposed to have a conversation about risk with peers when they talk to their clients. Their power to manipulate the markets is far less than everybody thinks it is and ultimately they are regulated by the same people who regulate banks.
Retail investors do not use hedge funds; on average they ultimately put their money in the hands of an investment manager. These professionals are handsomely paid because of their expertise, i.e. the ability to make "wise" investment decisions that will provide a better than average rate of return for the clients' savings.
If you have a pension you ultimately use an investment manager. If you are an investor you should have agreed a risk profile for your investments and your investment manager should stick to it; if that does not happen you can sue. So, why put together a set of rules that will make it more expensive to operate an investment fund and will limit the choice of investment?
Alternative Investments (i.e. Private Equity, Hedge Funds, etc.) hardly played any part in the events that led to the credit crunch and the massive bailout of banks. But they have been an easy target for populists attacks, in time of crisis massive wealth is guilty by definition (if I am in trouble why aren’t you?).
If regulators cannot properly monitor international flow of capital, shouldn’t we look at why they can’t and try to solve that rather than add more regulations to make matters more complicated than they need to be?
Money can easily be moved across borders, even more so when it moves electronically. Post 1929 crash, protectionism made things worse for everybody. In those days, they were protecting local goods, thereby stifling international trade. Now there is an attempt to build a financial ‘fortress Europe’.
How will it affect us in practical terms? What good are regulations if they are not properly implemented? Surely part of the blame of what happened rests on regulators where the staff sometimes did not fully understand the dynamics of the risks associated to some financial instruments. The more prudent thing would surely have been to look into the regulators before adding new rules to monitor. Unfortunately that was the more difficult option and politicians on both sides of the Atlantic failed to follow it.
Investors will have less choice and the new regulations will increase the cost of compliance and ultimately the retail client will end up paying for it.
Will they make the market less volatile? Will they promote prudent risk management? The jury is out on that. Personally I do not think so.
Will they be effective? Greed and ambition are huge motivators for the best and the brightest. In this case, greed and ambition will be the greatest motivators to find ways around these regulations.
Will they protect us from financial instability? I doubt it, for every Bernie Madoff there are dozens of hedge fund managers that have delivered better return for investors. (Please let us remember that there had been a lot of warning signs that something was not quite right in the Madoff Empire). The industry has been a convenient scapegoat. A lot of those who lacked judgement have been left more or less unscathed it is true but ultimately the regulations are only good or bad in so far as the regulators are good or bad; unfortunately the track record of the regulators has not always been shiny.